Forex: Bank Research Consensus Weekly 01.14.13

The main event this week was the ECB meeting. ECB president Mario Draghi firmly closed the door to further rate cuts, saying that the decision was unanimous and that rate cuts had not been on the agenda. Considering that ECB staff projections are already very downbeat, the probability of a new ECB rate cut is now be very slim. It removes yet another tail-risk for the euro and, in our view, the move well above 1.32 in EUR/USD after the Draghi comments is fully justified. It is now clear that for at least the next six months relative monetary policy will remain EUR/USD supportive, as the Fed will continue to expand its balance sheet. We forecast 1.35 on a three- to six-month horizon for EUR/USD. However, we doubt we are in for new strong uptrend in EUR/USD. The so-called IMM data show that speculators have already closed the speculative net short EUR/USD positions that were established last year when the outlook for the eurozone was much more uncertain. Hence, the next move higher in EUR/USD is more difficult to achieve and if speculators are to support the move, new net long EUR/USD positions need to be established. Considering that the eurozone still looks fragile compared with the US and that the debt ceiling and fiscal negotiations are the next focal point for the market, there certainly look to be some USD supportive factors over the next two months.

Treasury benchmark rates trade in a global marketplace and that has become evident in recent years and again this past week. Within the U.S. domestic market, the Fed still sets the benchmark for short-term interest rates and with economic growth off to a slow start in 2013, the Federal Reserve will keep policy on hold for the foreseeable future. We expect Fed purchases of securities to continue, thereby increasing its balance sheet, and liquidity in the marketplace to continue all year.

Nobody would dare and doubt the resolve of Fed Chairman Bernanke when he claimed that if “we could wave a magic wand and get unemployment down to 5 percent tomorrow, obviously we would do that”; but, in the absence of magic, Mr. Bernanke and his colleagues at the FOMC decided this week to stick with other tricks from their repertoire. First, they decided to continue buying agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities, initially to the tune of $45 billion per month. Finally, the Committee also modified its guidance about future changes to the interest rate. Namely, they anticipate that the federal funds rate is likely to stay exceptionally low at least as long as the unemployment rate remains above 6.5%, provided that inflation over the next two years is projected not to exceed 2.5%, and that longer-term inflation expectations remain stable. However, Chairman Bernanke emphasized that these thresholds are not automatic triggers for rate increases, but rather guideposts in terms of when the reduction of accommodation could begin.

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